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cost of debt

Cost of Debt: Reasons You Need a Kick Ass Credit Score

Debt affects your credit score and makes life more expensive. We’ll show you the cost of debt and reasons you need a kick ass credit score.

A good credit score saves you money in many ways. You don’t have to achieve the “perfect” score but having a score above 760 will go a long way towards making life cheaper.

What is a Credit Score?

A credit score is a number calculated using a number of factors to show how creditworthy you are. Lenders use this number to decide whether or not to lend you money, what rate of interest you will pay on that loan and in the case of credit card companies, whether or not to issue you a card and what your limit will be. Credit card interest rates are pre-set so your score doesn’t affect that.

What Makes Up a Credit Score?

There are six major components that make up your credit score. We did an in-depth article on it but to quickly re-cap, these are the factors;

Payment History: If you pay your bills on time.

Utilization: How much of your available credit is being used.

Derogatory Marks: Do you have delinquent accounts, past bankruptcies, judgments against you etc?

Length of Credit History: How long you have had a credit file.

Total Accounts: How many credit accounts you have open and how many types (credit card, mortgage, student loan, etc)

Credit Inquiries: How many times has your credit been checked because you’ve applied for a new credit card or loan.

What is a Good Score?

There is a range your score can fall into. Each credit bureau has their own scale but in general the ranges are as follows

*300-630 is bad.
* 630-689 is fair.
* 690-719 is good.
* 720-850 is excellent.

Either end of those is pretty hard to achieve and some people obsess over their credit score way more than necessary. There are lots of reasons you need a kick ass credit score but kick ass can be achieved at 760. So if you are there, you’re set.

Reasons You Need a Kick Ass Credit Score

If you don’t have a kick ass credit score, here are some reasons to get one.

Interest Rates

This is the big one. The two most expensive things in life are taxes and interest and if you can avoid them, you will reach financial independence much faster. If you want to buy a home, a car, or borrow money for anything from starting a business to renovating your house, your credit score will determine the rate of interest the lender sets for the loan.

What’s a point here and a point there? A lot when we’re talking about interest rates. If you buy a $300,000 house with 20% ($60,000) down with a 30 year fixed rate mortgage at 4.5% rather than 5.5%, over the life of that loan, you will save $52,794.

Your monthly payment at 4.5% will be $1,216 versus $1,363 at 5.5%. That’s an extra $147 per month. If you invested that $147 every month at an average return of 7% a year and did that for 30 years, the same length of your mortgage, you would have $180,381.86.

Just that little one percent difference could mean a difference of more than $200,000.

Job Search

Employers may pull your credit report as part of a back ground check. This is most likely to happen if the position involves handling cash, access to personnel files or a senior level position that requires a lot of decision making.

You can see why a potential employer would want this information in those circumstances; people who have poor credit could be thought more likely to steal either money or the identity of another employee that could be used to open credit accounts and if your decisions led to a poor credit report, they could lead to bad decisions for the company.

These kind of checks are usually not done early in the process, they come when the employer is almost ready to offer the candidate a job. If it comes down to a choice between two equally qualified candidates, a bad credit report could be the difference.

Choices

Having a kick ass credit score gives you more choices. If you want to buy a home or car, you will have more lenders willing to loan you money. You can choose the best offer. If you are renting an apartment you will be able to choose among more neighborhoods. Apartments that don’t do credit checks or have low requirements are not going to be in the nicer areas.

If you want to leave your job and start your own business, you can do that if you have good credit because you can more easily get a business loan.

Apartments

Most landlords and management companies will do a credit check before renting an apartment. If your credit isn’t good, they may not rent to you at all. Some will still rent to people with bad credit but may require a much bigger security deposit or a guarantor.

Utilities

If you have poor credit, utility companies may require a deposit to turn on electricity, phone service, water, and gas. Moving is already expensive and when you have to pay more to have the utilities turned on, coupled with paying a bigger deposit on the apartment you’re moving into, it can really be a hardship.

Good Credit Cards

Not all credit cards are created equal and not everyone who applies for a given card will qualify. To get the good cards, you have to have a good credit. A good credit card comes with all sorts of perks; free hotel stays and flights, airport lounge access, reimbursement when you pay for Global Entry and TSA Pre-Check, concierge services, consumer protections, and cash back.

Insurance

Insurance companies, whether home, auto, health or life, are in the business of taking risks. They want the price you pay to reflect how much risk they are taking by insuring you. To do this, many companies compile an insurance score, similar to a credit score. Part of what they use to come to the insurance score is information from your credit report.

Companies use the number to determine how likely you are to file a claim, miss or make late payments, or file a fraudulent claim. Home insurance rates for those with poor credit are two times higher on average than those with excellent credit.

Health insurance companies want to know if you have a good payment history but you only need to worry about this if you pay privately for insurance. If you’re covered under your employer, they won’t check your credit score because the payments are automatically deducted from your pay check.

Credit scores can correlate to behavior. People who are responsible with their money tend to be responsible with their health too so you can see why health and life insurers find your credit score relevant.

How to Build or Improve a Credit Score

There are lots of ways to build a credit score if you have what is called a “thin file.” If you don’t have enough history to be approved for a regular credit card, you can apply for a secured card. You provide a deposit and that amount is your credit limit. After a time, if you have used the card responsibly, you can apply or sometimes be upgraded with the same company that issued the secured card, to a traditional credit card.

If you’re in college, you can apply for a student card. The bar to be approved is lower than for a traditional card. The same is true of some retailer issued credit cards. Some landlords and utility companies report payment history to the credit bureaus.

You can become an authorized user on someone else’s card. You have access to credit but the person the card was originally issued to is responsible for paying the bill. Using a card this way can build credit but not all cards report authorized user activity to the credit reporting bureaus so check first.

You can get a credit builder loan. You borrow money but it’s held by the lender and only released to you after you have paid the loan back.

If you need to improve bad credit, you can follow the same advice for building credit but there are a lot of additional things you can do as well.

If your score is low due to late payments, set up phone alerts a few days before a due date and schedule the alert to go off at a time you know you will be in front of a computer to pay the bill. There is no point in an alert that goes off when you’re driving to work, you might forget once you arrive.

Some credit card companies allow you to choose your own payment date. If you have that option, choose dates that are easy to remember, the 1st, the 15th, the 24th because it’s your lucky number. That way you have fewer dates to keep track of. Just be sure you don’t cluster so many payment dates that you don’t have enough to pay all of the bills due.

If you still have any credit cards, ask for an increase in your spending limit. You may be turned down but it doesn’t hurt to ask and if you’re approved, it lowers your utilization, one of the factors making up your score. For the same reason and for length of history, don’t close credit accounts once you’ve paid them off. Many people close paid accounts thinking it improves their score but it actually hurts you.

If you’ve been haphazardly paying off your cards, just throwing money at the balances randomly, have a plan. Use the stacking or snowball method so you can pay the debts off more quickly and improve your score.

You Can’t Opt Out

You might decide this all this is too much hassle and you’re not going to play the game. You’re going to pay cash for everything so it doesn’t matter what your credit score is. And you can do that but it means you lose some of the benefits of a good credit score, like lower insurance rates.

It hurts your cash flow. You can pay cash for a home but that’s a lot of cash tied up in a non-liquid asset, cash that you can’t use to invest and cash that you don’t have in case of an emergency. You lose the buyer protections credit cards provide like extended warranties when you buy things with cash.

Having a credit score doesn’t have to mean drowning in debt. You can have one or multiple credit cards and pay them off in full every month; no debt. You can take your time paying down student loan or mortgage debt because the money you invest instead is giving you a higher return than the rate of interest on those debts.

Using credit in a way that adds up to a good credit score makes life cheaper.

Show Notes

E Credit Attorney: A company that can help clean up mistakes on your credit report.

Maxed Out:  A documentary about credit practices.

Ready For Zero:  A service to help you track and pay off your debts faster.

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  • It’s just recently that I know that if you don’t have a credit card, then it would be a long process for you for an approval of the mortgage. And I didn’t know that it would affect the Insurance rates also.

  • Erin

    On the employer checking credit thing: those with bad credit are more likely to be in financial straits which provides incentive to steal from the company. Employers most likely to pull reports are in sensitive industries, like finance and government as the employee may have the opportunity to embezzle in these fields.

    • That’s a great point Erin, I didn’t even think of that!

    • That’s a great point Erin, I didn’t even think of that!

  • Shannon_ReadyForZero

    Great show guys! Thanks for the shout out – let us know how the payoff goes for you :).

  • Bron

    Did you know that having a 0% utilization is a negative factor in your score. I pay my balances before the statement closes and I end up have a 0% utilization which lowers my score a bit. Best practice is to pay your card in full after your statement is issued. This part of the scoring algorithm frustrates the crap out of me.

    • Very interesting, that I did not know! And I just thought I was keeping a revolving balance cause I was milking their free cash ;)